the u.s. water industry: structure, regulation, and pricing · forty-five states regulate about...

THE U.S. WATER INDUSTRY: STRUCTURE, REGULATION, AND PRICING

JANUARY 2009 – ROME, ITALY

© Janice A. Beecher, Ph.D. (2009)Institute of Public UtilitiesMichigan State University

[email protected] 517.355.1876Do not cite or distribute without permission

MICHIGAN STATE UNIVERSITY

rome09-2Beecher IPU-MSU

Public utilities as part of the U.S. economy(2002 census)

$ Bil. revenues % GDP

Telecom less cable $353.9 3.4%Electricity (G/T/D) Private $325.0 3.1%

State and local $54.4 0.5%Natural gas distribution Private $66.5 0.6%

State and local $5.8 0.1%Water and sewer Private $6.7 0.1%

State and local $60.3 0.6%Total $872.6 8.3%


Monopoly status of the utility sectors today

WaterArguably

most monopolistic

due to persistent

market fail-ures; policy is fragmented

ElectricityRestructuring

has introduced

markets with mixed results;

state policy varies

TelecomArguably

least monopolistic

due to technologies;

policy is relatively

centralized

Gas Development of competitive

wholesale markets;

policy roles are distinctive


Water industry structureThe water industry is

Fragmented (lots of systems resulting from unchecked development)Bifurcated (by size and by ownership)Concentrated (at the large end, both public and private)Pluralistic (many often competing interests)

Structural character is defined in terms of Size of systemsOwnership of assetsManagement of operationsInterconnection (limited local and regional)

A water “system” is not always a utilityUtilities may own multiple systemsSome systems are interconnected and purchase water on a wholesale basis (about 15%)


Water: a $100+ billion industry

Water utilities, $36.2

Wastewater utilities, $36.5

Equipment and chemicals, $25.9

Engineering, consulting, and analysis, $12.0

Estimated size of the the water industry: $110 billion in 2006


Water systems in the U.S. (2007)

Systems Population served (mil.)Nontransient noncommunity 18,839 6,334Transient noncommunity 84,744 13,752Community water systems 52,110 286,451

0

50,000

100,000

150,000

200,000

250,000

300,000


http://www.epa.gov/safewater/consumer/cwss_2000_volume_i.pdf

Community systems by population served (2007): many systems serve few people

56%

27%

9%7%

1%2%

7%10%

37%

45%

0%

10%

20%

30%

40%

50%

60%

Very small (pop. <501)

Small (501-3,300) Medium (3,301-10,000)

Large (10,001-100,000)

Very large (>100,000)

% systems % pop. served


http://www.epa.gov/safewater/consumer/cwss_2000_volume_i.pdf

Water systems by size and ownership (2000): many small systems are privately owned

6,487

11,282 4,315 2,957470

22,632

2,734 738 52646

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Very small(pop. <501)

Small (501-3,300)

Medium (3,301-10,000)

Large (10,001-100,000)

Very large(>100,000)

Public Private


Privatization: two distinct models


U.S. water industry concentration

Company Stock ticker

Sales revenues (2007 mil.)

American Water AWK $ 2,214Aqua America, Inc. WTR 603United Water (Suez) – naCalifornia Water Service CWT 367American States Water AWR 301SouthWest Water SWWC 217San Jose Water SJW 207Aquarion (Macquarie) – naMiddlesex Water MSEX 86Utilities, Inc. (AIG) – 63Connecticut Water CTWS 59Artesian Resources ARTNA 53Baton Rouge Water – 40The York Water YORW 31Pennichuck Corporation PNNW 30


Private share of the U.S. water market

0%

5%

10%

15%

20%

25%

30%

35%

40%

$0

$5

$10

$15

$20

$25

$30

$35

$4019

80

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Private market share for the water industry

Annual water utility revenues ($bil.)

Private market share % (NAWC)

Poly. (Annual water utility revenues ($bil.))

Poly. (Private market share % (NAWC))


Structural change in the water sectorChange drivers include concerns about

Efficiency in pricing and resource allocationInfrastructure investment needsEnvironmental constraintsRising costs and prices and their impactOwnership and jurisdictional options

Structural change includesConsolidation, holding companies, private equity, foreignInstitutional contestability (public v, private ownership)Convergence and integrative solutions (water/wastewater/energy)

Environmental and economic regulators provide some incentives for structural change(SDWA)Competition is limited, although market mechanisms (e.g., competitive bidding, contracts, and pricing) can be used


Water federalism and jurisdiction

Federal Interstate States (primacy) Sub-state Local

Water quantity

River basin agencies(varies)

Resourceagencies

Management districts(varies)

Water quality

Congress, EPA (CWA,

SDWA)

SDWA primacy agencies

Health departments

Water funding

Revolving fund

agencies

Water prices

PUCs (private

systems)

Public ownership, other local controls


PUC jurisdiction for waterEconomic regulation by the states is based on persistent market failure in the form of monopoly (private, some publics)Forty-five states regulate about 8,000 water utilities and about 1,000 sewer companies (including combos)Commission jurisdiction covers about 20% of all community water systems; some are “multi-system”About half are investor-owned (private); the rest are divided evenly between municipals, water districts or authorities, and nonprofits and cooperativesMany non-jurisdictional utilities (munis) follow regulatory accounting, ratemaking, and other practicesEconomic regulation focuses on prudence, profits, price – but PUCs may also impose service-quality standards, including pressure and aesthetics (color, taste, odor)


Economic regulation of water utilitiesWater/sewer utilities demonstrate significant and persistent market failure

Strong tendency toward vertically integrated monopolyCost structure• High capital intensity even among utilities (ratio of assets to revenues)• Long-life fixed assets and associated financing, depreciation, and

intergenerational equity issues• Economics of scale, scope, density, and integrationExternalities (positive and negative)Characteristics (and perceptions) of public goods Other technical, economic, and policy limits to competition (e.g., entry)

In the presence of market failure—particularly monopoly—economic regulation is a proxy for competition to prevent abuse of market power (i.e., undue price discrimination or degradation of service quality)Economic regulation involves standards, accountability, and incentives


Household expenditures on utilities (U.S.)

Electricity ($1,586; 2.5% of

expenditures)37%

Telephone ($1,439; 2.3% of

expenditures)33%

Natural gas ($644, 1% of expenditures)

15%

Fuel oil and other fuels

($147, .2% of expenditures)

3%

Water and other public services ($532, .8% of expenditures)

12%

Consumer expenditures on utilities for a four-person household in 2006 [$4,347 and 6.8% of total expenditures]


Utilities as a percentage of income (regressivity)

4.1% 3.6%3.0% 2.5%

1.9%

3.1%2.9%

2.6%2.3%

1.6%

1.5%

1.4%

1.2%

1.0%

0.8%

0.4%

0.3%

0.3%

0.3%

0.2%

1.1%

1.0%

0.9%

0.8%

0.6%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Lowest quintile 2nd quintile 3rd quintile 4th quintile Highest quintile

Consumer expenditures on utilities by income quintile (all consumers %)

Water and other public services


Natural gas

Telephone

Electricity

$843 $1,083 $1,237 $1,407$1,759

$634

$862$1,089

$1,297

$1,551

$306

$426

$477

$575

$759

$87

$105

$121

$155

$223

$220

$307

$383

$467

$610

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

Lowest quintile 2nd quintile 3rd quintile 4th quintile Highest quintile

Consumer expenditures on utilities by income quintile (all consumers $)

Water and other public services


Natural gas

Telephone

Electricity


1982-1984 = 100 except for cellular (1997=100)

Consumer price trends for utilities (U.S.)

0

50

100

150

200

250

300

350

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

Trends in the consumer prices (CPI) for utilities [1977 to 2007]

Cable/sat. television

Garbage

Water and sewer

Fuel oil

Local phone

Natural gas

ALL ITEMS (CPI)

Postage

Electricity

Internet (1997=100)

Wireless (1997=100)

Interstate phone

-160

-120

-80

-40

0

40

80

120

160

1913

1917

1921

1925

1929

1933

1937

1941

1945

1949

1953

1957

1961

1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

Difference between CPI for utilities and overall CPI (1983-1984=100)

Cable/sat. television

Water and sewer

Local phone

Natural gas

Electricity

Interstate phone


Water financing needs

rates

gap


U.S. water withdrawals and population (USGS)

Pop.


Trend in residential water demand

80,000

85,000

90,000

95,000

100,000

105,000

110,000

115,000

120,00019

72

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Annual residential gallons sold per residential customer (NAWC)

5 per. Mov. Avg. (Series1)


Pressure on water pricesPressures

Prices probably do not reflect true economic value (willingness to charge)Rising costs coupled with flat or declining demandCombined water, wastewater, stormwater costsInfrastructure replacement needsDepreciation expensesRegulatory compliance costsImpact of energy markets and costsHistoric under-pricing (public systems)Incentives for conservation and efficiency

ConcernsAffordability, regressivity, subsidy, and intergenerational equityRate shock and rate design options

Still, tap water still compares favorably to other utilities and to bottled water


Reasons for the public-private rate disparityProfits (return on equity)Taxes (all levels) Financing (including SRF)Intergovernmental transfers and subsidies (often hidden)Costing practices (depreciation expense)Rate practices (inside/outside rates)Special charges (system development)Investment deferral (by cities)Cost differentials, including scale (in some cases) Economic regulation (cost-of-service based ratemaking)


Revenue requirements formula

RR = r(RB) + O&M + D + T

where:

RR = annualized revenue requirementsr = authorized rate of return RB = ratebase (original cost of utility plant in

service net of accumulated depreciation)O&M = operation & maintenance expenseD = depreciation expenseT = taxes


R

even

ue re

quire

men

ts

Var

iabl

e op

erat

ing

cost

s

Labor

Above the line: ratepayers cover

the prudent cost of service

Energy Other inputs and variable

operating costs

Fi

xed

cost

s

Taxes, insurance, other fixed

costs

Cap

ital r

ecov

ery

Depreciation C

ost o

f ca

pita

l Interest on

debt Below the line:

ratepayers compensate debt

holders and shareholders (net)

Return on equity

Components of revenue requirements


Basic rate-design options (many variations)

Price/unit

Quantity consumed

increasing-block

Uniform and uniform by class

decreasing-block

tier breakpoint


Survey of water rates

Based on data from Raftelis (2006)

-$25

$0

$25

$50

$75

$100

$125

$150

$175

$200Monthly water bills based on usage (260 utilities, Raftelis survey, 2006)

0 gal 3,740 gal 7,480 gal 11,220 gal 22,440 gal

Monthly charge for 0 water

Seattle,WA - summer

Corona, CA


Sample water bill


Issues in water costs and pricesPricing is based on metered use; varies by customer class (meter size) Full-cost pricing and profiting from water are challengingCost profile (high fixed costs) presents a dilemma for water

High fixed charges = less incentive to sell but less conservation High variable charges = more conservation but more incentive to sell

Rising costs, supply constraints, and climate change are bringing focus to Water system sustainability and efficiencyWater-energy interdependenciesWater availability and affordabilityEnvironmental externalities (+/-)Elasticity and pricing incentivesTrends in water demand and financial effectsNew technologies and decentralized solutions


ipu.msu.edu [email protected]

the u.s. water industry: structure, regulation, and pricing · forty-five states regulate about...

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